Short term capital losses subject to STT can be set off against Short term capital gains not subject to STT

Background:-The Finance Act, 2004 introduced section 111A in the Income-tax Act, 1961 (the Act) prescribing a tax rate of 10 percent on Short Term Capital Gains (STCG) arising from sale of shares on or after 1 October 2004 on a stock exchange which are subject to Securities Transaction Tax (STT).

Before this amendment the STCG arising to non-residents (up to 30 September 2004) was taxable at the rate of 30 percent under the provision of section 115AD of the Act.

Recently, the Mumbai Income-tax Appellate Tribunal (the Tribunal) in the case of First State Investments (Hongkong) Ltd. [A/C First State Asia Innovation & Technology Fund] v. ADIT (2009-TIOL-547-ITAT-MUM)  dealt with the issue of set off of Short Term Capital Loss (STCL) incurred from sale of shares on or after 1 October 2004 against STCG arose up to 30 September 2004. The Tribunal held that STCL (if gains then they are subject STT and to be taxed @ 10 percent) incurred on or after 1 October 2004 can be set off against the STCG (not subject to STT and to be taxed @ 30 percent) arose up to 30 September 2004.

Facts of the case

• The taxpayer was a non-resident and registered with SEBI as a sub account of First State Investment (Hongkong) Limited, which was registered as Foreign Institutional Investor. During the year the taxpayer earned income from capital gains on sale of shares. At the time of calculating the amount taxable under the head capital gains, the taxpayer set off STCL subject to STT first against STCG not subject to STT and offered the balance STCG to tax.
• However, the Assessing Officer (AO) contended that the taxpayer had wrongly set off the STCL subject to STT against the STCG not subject to STT with the object of reducing the incidence of tax payable on STCG. Accordingly, the AO rejected the taxpayer’s calculation and calculated the net STCG after setting off against each category separately.

The computations prepared by the taxpayer and adjusted by the AO are given below:

Computation by taxpayer

Computation by AO

Taxpayer’s contention

• As per section 70(2) of the Act, the taxpayer had a choice of setting off any STCL against any STCG from any other short term capital asset. The Act does not prescribe any order in which specific STCL should be set off against specific STCG.
• Further, the taxpayer relied on the decision of Special Bench of Mumbai Tribunal in the case of JCIT Vs. Montgomery Emerging Markets Fund [2006] 100 ITD 217 (Mum) (SB) where it was held that in the absence of such description, the interpretation of the provision in favour of the taxpayer should be adopted.

Tax department’s contention: – The tax department contended that since there were two different provisions and tax rates for the transactions entered up to 30 September 2004 and on or after 1 October 2004 the taxpayer cannot set off the losses of lower rate against the gain of higher rate.

Tribunal’s Ruling

• The words used in section 70(2) of the Act were that “the assessee shall be entitled” represents that the option lies with the taxpayer to decide the manner in which STCL from the first transaction will be set off against the STCG from any other transactions.
• If the intention of the legislature had been not to confer the choice on the taxpayer in the matter of setting off the STCG of the pre-cutoff date, it would have clearly set out such intention in the language of section 70(2) of the Act itself. In the absence of any stipulation in this regard the choice has been left over to the taxpayer in taking decision about the setting off of STCL from one transaction against any other STCG, whether within, or outside the cut-off date.
• If higher benefit is available from the exercise of the option in a particular way vis-à-vis the lower benefit resulting in the other way, then the higher benefit available as per law should not be denied. The Special Bench of the Tribunal in the case of Mantgomery Emerging Market Fund has also ruled in favour of the taxpayer by holding that the set off of long term capital loss against the STCG was permissible under section 70 of the Act, in the period prior to the amendment.
• Sections 111A and 115AD of the Act falls in Chapter XII, which provides for determination of tax in certain special cases. Thus, it is clear that all these sections falling under chapter XII provide for a particular rate of tax to be applied on the incomes covered under these sections individually. Hence, these sections do not deal with the computation of income but only provide for the rate of tax applicable on the income.
• Accordingly, the Tribunal held that the taxpayer was allowed to set off STCL incurred on or after 1 October 2004 against the STCG arose up to 30 September 2004.

Our comments

• The Mumbai Tribunal has laid down a very important proposition that there is nothing in section 70, 71 to specifically prevent the STCL which are subject to STT being set off against STCG which are not subject to STT.
• This decision could be helpful for setting off losses in transactions subject to STT with the STCG not subject STT for off-market transactions like buy back, open offer, etc.
• It would be interesting to note that by relying on this decision whether it could be possible to contend that even in the case of long term capital loss (subject to STT) , a set off is possible against the long term capital gain arising from off-market transactions. It may be interesting to note that the XLS utility does not permit negative values (loss) being entered in the Schedule EI (Exempted Income) and only a positive capital gains could be stated there.

NF